TC: There is a problem with the money numbers at the moment in the UK. Three or four years ago, banks were creating semi-bank subsidiaries, to bypass capital rules. Deposits have been held in those subsidiaries, and they have been doing all sorts of very odd things in the last year or two. Because of that, the Bank of England has correctly taken out these semi-bank deposits from the measure of money they and other economists look at. This measure is called M4x, with the "x" denoting that they've excluded these semi-bank deposits.
And the relationship between that M4x measure and what's happened to demand in the economy shows that this was the driving force behind this cyclical episode, as it was behind the cyclical episode in the late 1980s, the boom-bust then, and the boom-bust in the early 1970s and mid '70s, both of which I've written about at some length. If you're running a business, how much money you have in the bank is critical. And if all the businesses in the country find that their cash balance — the amount of money they have in the bank — is being squeezed, then you will get a thumping great big recession. And I'm afraid the latest episode is dramatic confirmation of the relevance of money to macroeconomic outcomes. To end the recession you need more money in the economy: that is the critical point.
RS: Of course you need more money in the economy. It's the relationship between money and the real economy that is crucial. I would agree — banks have to lend more, and it's also the case that people have to want to borrow more, and that depends on companies' profit expectations. What I think you're missing from the whole thing is the issue of psychology and confidence.
Let me go back to a point that you made earlier, which is that fiscal policy is irrelevant. Certainly, the amount of discretionary fiscal stimulus has been quite small so far, though more is coming on. But that excludes the automatic stabilisers. In fact the government has been running a very large fiscal deficit. Despite this huge injection of money into the banking system, Mervyn King himself said: "The recovery hasn't happened." If this is the best that monetary policy can do, we certainly need fiscal policy as well.
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